Foreign Investments in Emerging Markets Jose W. Fernandez Ronald Kirk Rahim Moloo February 11, 2015
Overview The rapid growth of emerging markets can provide investors with higher expected returns and diversification benefits. Investing in these markets exposes the investor to risks, including political instability and legal insecurity. Risks can be mitigated through understanding host country s legal environment and structuring investment to protect expectations. 2
Contents I. Facts and Figures: The Current State of Foreign Investment in Emerging Markets II. Due Diligence: Assessing the Legal Environment and Making an Informed Decision to Invest III. Protecting Your Investment: Structuring the Transaction to Mitigate Risk 3
Facts and Figures: The Current State of Foreign Investment in Emerging Markets 4
Global Foreign Direct Investment Flows from 1999 to 2013 (USD billion) Global Foreign Direct Investment Flows Q1 2013 to Q2 2014 (USD billion) Sources: OECD and IMF, FDI in Figures, December 2014; UNCTAD, World Investment Report Overview, 2014. 5
Flow of Foreign Direct Investment Investment is flowing to developing and transition economies. Developed Countries (39%) Developing Countries (54%) Transition Economies (7%) Source: UNCTAD, World Investment Report Overview, 2014. 6
Top 20 Host Economies (2012 to 2013) United States China Russian Federation Hong Kong, China Brazil Singapore Canada Australia Spain Mexico United Kingdom Ireland Luxembourg India Germany Netherlands Chile Indonesia <Presentation Title/Client Name> Colombia Italy Source: UNCTAD, World Investment Report Overview, 2014. 7
Regional Trends Africa Increase in FDI driven by Eastern and Southern subregions Expectations of growing middle class Opportunities in infrastructure and oil and gas industry Central and Latin America Growing FDI inflows Opportunities in infrastructure and oil and gas industry (especially given low oil prices) Developing Asia Total FDI inflows of $426 billion in 2013 7.1% projected growth rate for China s GDP in 2015 6.4% projected growth rate for India s GDP in 2015 Sources: UNCTAD, World Investment Report Overview, 2014; World Bank, Forecast Table, 2015; The Economist, Gauging Growth in 2015, Jan. 5. 2015. 8
Due Diligence: Assessing the Legal Environment and Making an Informed Decision to Invest 9
<Presentation Title/Client Name> Initial Steps Identify the Challenges: Unfamiliarity Lack of transparency Evolving environment Prepare to Meet those Challenges: Assemble a team Identify and retain counsel Accountants Trusted local staff/partners Begin with the basics Ownership and control Due diligence Local support for the investment/project 10
Due Diligence: Factors to Consider Identify mechanism of investment Greenfield asset development Merger or acquisition Equity investment Project financing Basic Legal Considerations Available corporate structures Necessary permits Tax system Exchange rate systems Domestic foreign investment law Reporting requirements 11
Due Diligence: Factors to Consider Domestic Court System Independence Quality Average time to disposition Other Legal Frameworks Impacting Investment Competition Environmental Intellectual Property Labor and Employment Real Estate Laws What the law says versus what is actually happening on the ground 12
Legal Frameworks Impacting Investment Competition Laws Enforcement agencies Exceptions for State-Owned Enterprises Environmental laws Permitting requirements Potential liability Administrative enforcement Labor and Employment Laws Labor-management relations and unions Hiring-and-firing; discrimination; wages Intellectual Property Laws International treaties on intellectual property protection Penalties and deterrence Real Estate Laws Title searches Ownership rights 13
Corruption Concerns The Foreign Corrupt Practices Act (FCPA) penalizes U.S. businesses that make corrupt payments abroad. Many other legal systems have adopted similar legislation governing outward investors. Host countries may also have anticorruption laws and reporting regimes in place. Corruption Perceptions Index Photo: Transparency International--2014 Corruption Perceptions Index 14
Private Equity Due Diligence in Emerging Markets Enough deal flow? Deal flow in a market indicates motives to sell equity to third parties, access to leverage, functionality of the legal system, and size of the economy. How are returns made in the market? How local is the team? Seek GPs who have local experience and can manage risks Availability of attractive exits Are contracts enforceable? Source: OPIC/IFC Due Diligence in Emerging Markets 15
Protecting Your Investment: Structuring the Transaction to Avoid Uncertainty 16
Protecting Your Investment 1. Take advantage of existing protections. Investment, trade and tax treaties provide substantive and procedural rights. 2. Craft your own protection. Include provisions in contracts to account for risks. 17
International Investment Treaties An agreement made between two or more States that safeguards investments made in the territory of the signatory countries. Bilateral Investment Treaties (BITs) treaty between two states designed to promote and protect investments by nationals of the Home State in the territory of the Host State Multilateral Investment Treaties (MITs) an accord between multiple countries providing rights and protections for foreign investment within the network of participating Host States Offer protection and rights directly to investors, who can bring a claim against a Host State of the investment without need for (a) contract with the Host State or (b) any intervention from the Home State 18
Proliferation of BITs The first BIT was signed between Germany and Pakistan in 1959 By 1990, there were over 300 BITs Today, there are over 3,000 international investment agreements; over 2,000 are BITs UNCTAD World Investment Report 2014 19
Relevant Multilateral Treaties Free Trade Agreements e.g. Chapter 11 of NAFTA includes investment protection provisions offering effective means of protecting investments The Energy Charter Treaty (ECT) ECT provides for protection of energy-related investments More than 50 States (plus the EU) are party to the ECT ASEAN Comprehensive Investment Agreement Regional grouping of Southeast Asian nations for cooperation mainly in areas concerning economic development Human Rights Treaties Protecting investments overlaps with the human right to the peaceful enjoyment of property 20
Proliferation of Investor-State Treaty Arbitration First BIT arbitration commented in 1987 (Asian Agricultural Products Limited v. Democratic Socialist Republic of Sri Lanka) Today, there have been over 500 known investor-state treaty arbitrations Most cases have been filed with ICSID In 2013: 57 known investor-state arbitrations (31 with ICSID) UNCTAD IIA Issues Note, No. 1, April 2014 21
Substantive and Procedural Protection Substantive Rights: Expropriation protection from substantial interference with property/investment Fair and Equitable Treatment (FET) protects legitimate expectations of the investor Most-Favored Nation (MFN) Treatment protection from discriminatory treatment Free Transfer of Funds the right to freely transfer funds into and out of the Host State without unreasonable delay Umbrella Clause obliges the Host State to observe specific undertakings towards foreign investors Procedural Rights: Arbitration directly with the Host State in a reliable, neutral forum to enforce the rules in a specific treaty Ad Hoc Arbitration pursuant to UNCITRAL Rules Designated Arbitration Institutions (e.g., ICSID) 22
Securing Investment Treaty Protection HOME STATE Investment Treaty HOST STATE Encourages economic growth and enhances reputation. Bond of Nationality INVESTOR Arbitration without privity Protected by substantive and procedural rights afforded by the treaty. 23
Securing Investment Treaty Protection Investment treaties offer protections if: Protected investor Protected investment Dispute arose while treaty was in force and applicable Conditions for access to arbitration under the treaty and the arbitration rules must also be fulfilled. Waiting periods Fork-in-the-Road Conditions under ICSID Convention Art. 25 24
Potential Exclusions and Pitfalls <Presentation Title/Client Name> Carefully review each BIT to ensure there are no hidden traps or pitfalls. Common exclusions include: Subject Matter Exclusions carve-outs for measures to protect Host State s culture clauses allowing states to adopt measures necessary to meet specific objectives, such as protection of essential security interests Tax Carve-Outs Some BITs carve out tax measures from the scope of all substantive protections (e.g. nothing in [this treaty] shall impose obligations with respect to taxation measures. US Model BIT 2012) Denial of Benefits Clause Host State can deny the benefit of the BIT to investors under certain circumstances Prescribed Limitation Periods 25
Five-Step Analysis to Approaching BITs/MITs Step 1: Identify relevant BITs/MITs are they in force? Step 2: Ensure qualification for protection Step 3: Compare dispute resolution mechanisms Step 4: Compare principal substantive protections Step 5: Identify any potential exclusions or other pitfalls 26
Contractual Provisions to Protect Investment Choice of Law Provision Force Majeure Clause International Arbitration Clause Sovereign Immunity Waivers Other Project-Specific Considerations 27
The Choice of Law Clause Significance The system of law selected serves a crucial gap-filling function for the agreement. Silence on applicable law leads to unpredictability. Making the Choice Typically, the parties will select the law of the home or host country, but could select the law of a third country (though there are limits). Ensure the law is suitable should be internationally respected and compatible with the parties contractual expectations. Avoid unworkable compromises The law will apply as it is in effect at the time of the arbitration or litigation, not at the time that the contract was drafted. Consider whether to insert legal stability clause. 28
<Presentation Title/Client Name> Force Majeure Clause Suspends performance of contract for party impacted by extreme and unforeseeable event foreseen by the parties and included in the force majeure clause. Traditionally encompasses acts of God such as natural disasters, but can also be used to insure against risks like political turmoil, war, strikes, or other events that may negatively impact foreign investment 29
International Arbitration Clause Key Goals Produce a comprehensive agreement to arbitrate Minimize the risk of costly court detours Obtain an enforceable arbitration award Drafting Tips State clearly that the parties have agreed to binding arbitration Use a model clause whenever possible Do not equivocate Arbitration, if any, by ICC Rules in London Do not split potential disputes between arbitration and domestic courts 30
Key Choices in Negotiating and Drafting An International Arbitration Clause Rules Number/Selection of Arbitrators Choose Seat Applicable law Language Finality & Entry of Judgment Bells & Whistles 31
Waiver of Sovereign Immunity An explicit clause waiving immunity should be included when contracting with government or governmental agency or entity. While an arbitration clause may be considered a waiver with respect to the tribunal s jurisdiction, it might not be considered a waiver for the purpose of enforcing an award. 32
Other Project-Specific Considerations Appropriate Representations and Warranties Additional clauses to consider Indemnities for acquired risks Limitations of liability to mitigate future risks Provision for necessary insurance coverage Selection of currency for the contract 33
Conclusion Rapid growth of emerging markets provides unique investment opportunities. Awareness of the host country s legal environment and tools such as investment treaties and contractual clauses help to mitigate risks that accompany those opportunities. 34
Contact Information Jose W. Fernandez Partner New York Office Tel: 212.351.2376 jfernandez@gibsondunn.com Ron Kirk Senior Of Counsel Dallas Office Tel: 214.698.3295 rkirk@gibsondunn.com Rahim Moloo Of Counsel New York Office Tel: 212.351.2413 rmoloo@gibsondunn.com 35